Islamic economics prohibits interest on loans based on verses from the Quran that forbid riba, or usury. While interest is circumvented through sales contracts that provide extra profit to the lender, there is no agreement on a definition of an "interest-free" loan. Critics argue the Quran only bans excessive usury, not moderate interest rates, and that Islamic banking deceives by cloaking interest instead of openly dealing with it.

1. Finance :: Prohibition of Interest Rate in Islamic Finance
Islamic economics is referred to as the application of Islamic Shari'a law in economic activity. This
form of economics has attracted banks and financial institutions in more than 56 countries including
Europe and the United States; they cater to customers who want to invest in a halal instrument, or
according to Islamic teachings.
Muslim authors state that Islam offers solutions to solve problems of human civilization. They view
the financial problems facing developed countries in Africa and Asia are caused by interest-based
financial instruments which create "unrepayable debt" says Muhammad Ayub, author of
Understanding Islamic Finance. Mr. Ayub goes on to say that interest-based system makes "a class
of people richer and leaving others poorer and oppressed."
Suppose you deposit in a conventional bank $1000, at 4 percent interest for a period of one year. At
the end of the year, your return is predetermined at $1000+40. The bank will invest your money. If
it fell short of $1040, the bank will incur a loss. So an interest-based loan places the risk entirely on
the borrower, in this case, the bank. Under Islamic economics, this type of investment is prohibited
and is considered "un-Islamic" and "unfair."
The source of prohibition of interest is based on the Qur'an. Verse 2:275 reads: ". . .Allah permits
commerce and prohibits riba. . ." The etymology of the term riba comes from Aramaic raba meaning
'increase'. Muslim interpreters define this term as 'interest'. In pre-Islamic Arabia, a borrower saw
his debt double following a default and redouble if he defaulted again. If the borrower was unable to
pay off his debt, he would be pushed into enslavement until the debt is paid. Such a situation was
creating a social disharmony in Arabia, to which the Qur'an was responding. The ban on riba was
therefore an instrument used to avoid mistreatment of fellow citizens, when their financial situation
was in distress.

2. Among the Muslim community in the Middle East and elsewhere, financial transactions involving
interest on borrowed money are accomplished, but without mentioning the word 'interest'. For
example, Y wants to borrow from X $500 at 5 percent interest without violating the prohibition. X
buys a TV system from Y for $500 but then promptly returns it for $525, payable in one year
installments. The additional $25 represents interest but was not mentioned; it was circumvented
instead by the purchase of the TV and selling it, immediately, to the borrower at a higher price,
which is equivalent to the amount of interest.
The most popular instrument in Islamic banking is Murabaha, a contract of sale in which a
commodity is sold for a profit. The contract involves the purchase of real property by the financial
institution which then sells them to the client at an agreed mark-up. A repayment is usually in

3. installments. Accordingly, X wants to buy a car from the dealer and finance the transaction through
a bank. Under Islamic economics, the bank does not charge interest. So the bank will buy the car on
behalf of the buyer, and immediately sells it to X at the dealer's price plus an extra amount of money
for the time spent and the paperwork involved to finalize the deal, the extra amount represents
interest on the borrowed money, but the contract does not use the word 'interest'.
All Muslim authors and practitioners of Islamic finance agree that charging interest is a violation to
Islamic Shari'a, but there is no agreement on the definition of 'interest-free' loan. There is no
account for the rate of inflation in this Islamic instrument. In order to protect the purchasing power
of money, loans are indexed to the rate of inflation, which is absent from Islamic banking and was
proclaimed un-Islamic in two international conferences on indexation, one held in Islamabad in 1986
and the other in Jeddah in 1987.
Critics of interest-free banking claim that those who call for prohibition on interest are guilty of
misinterpreting the Qur'an and misreading Islamic history. The Qur'an bans, not interest rate, but
usury, or exorbitant interest.
Suleyman Uldag, a prominent Turkish author suggests that "even if interest were unlawful, it would
be a lesser sin to deal in interest openly than to cloak it in practices aimed at deception." He writes
that "Islamic banking is its own worst enemy."
Another attack on the prohibition of interest came in 1989 through a fatwa (Islamic legal opinion)
from Muhammad Sayyid Tantawi, the grand mufti of Egypt and head of the top Islamic university, al-
Azhar, who said that simple bank interest is permissible in Islam, while excessive interest rates
constitute riba (usury) and thus forbidden. Tantawi added that legitimate instruments, including
high-yield government bonds and interest-bearing saving accounts are compatible with Islamic
Shari'a. Tantawi's fatwa represented the minority view, and provoked considerable discussion
among the Muslim community in Egypt and around the world.